IEEJ: November 2014, All Rights Reserved

Research Paper

Recommendations to Realize
the Development of Sound LNG MarketNovember 2014
The Institute of Energy Economics, JapanIEEJ: November 2014, All Rights Reserved

Acknowledgement
The Institute of Energy Economics, Japan gratefully acknowledges the assistance of PhilipAndrews-Speed, Wayne Calder, Guy F.Caruso, Siri Jirapongphan, Madhura Joshi, Ki JoongKim, Ying Chieh Lai, Chia-Jung Lu, Jane Nakano, Jin Ho Park, Howard Rogers, AbhishekRohatgi, Anmol Soni, Laszlo Varro, and Tsou Yi-Cheng.

Anonymous reviewers fromAustralia, European Union, Qatar, Singapore, and United States of America provided helpfulcomments.

None of these individuals or organizations is identified with the content of this report, withany errors and/or with the opinions expressed.

Introduction
In parallel with the spectacular growth of the global LNG market in recent years - except for
the last couple of years - regional price gaps of the commodity have grown so significantly
as not seen in other energy sources. Particularly in Asia, the expensive prices have been
imposing grave macroeconomic burdens to regional economies and threatening future
growth of the local LNG markets. In order to bring back healthy growth of the market for LNG,
structural solutions are required to various issues observed in the global LNG marketplace.

This document has been drafted by the Institute of Energy Economics, Japan (IEEJ) with an
aim to make recommendations to stakeholders and governments to promote sounddevelopment of the LNG market, based on ideas formulated through discussions with agroup of experts, to be presented at the LNG Producer-Consumer Conference on 6November 2014 in Tokyo.

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IEEJ: November 2014, All Rights Reserved

Recommendations to Realize
the Development of Sound LNG Market(Draft, as of 31 October 2014)
1Stakeholders from both the supply and the demand sides are encouraged to make theirrespective efforts with regard to price formation and the development of a flexible andtransparent market in order to minimize regional price differences, in particular socalled “Asian Premium”. While the private sector is ultimately responsible forcommercial deals, the public sector should create an enabling environment to develop
a sound LNG market.

2Price formation
2.1

The stakeholders in the private sector are encouraged to pursue pricing
mechanisms that most appropriately and timely reflect prevailing LNG market
conditions, and can eventually serve as an alternative to oil indexation instructuring long term contracts.. This approach would lead to mutually acceptablelevels of prices that should result in the development of the sound LNG market
that is mutually and equitably beneficial to all stakeholders.

2.2

The public sector should create an environment suitable for the development of amarket that properly reflects regional supply and demand conditions, byliberalisingend

usermarkets,

supporting

developmentofnecessary

infrastructure and ensuring reasonable open access to relevant facilities, which
may lead more LNG spot transactions and arbitrages, as well as establishment of
Asian trading hubs,.
3Promotion of a flexible and transparent market
3.1

The stakeholders in the private sector are encouraged to eliminate destination
restrictions in FOB LNG transactions and relax them in DES transactions.
* FOB = free on board; DES = delivered ex-ship

3.2

The private and public sectors should collaborate to strengthen market function
to disseminate highly transparent pricing terms and other market information,
including short-term and long-term supply-demand outlooks.

4

Cooperation between stakeholders along the whole value chain
4.1

The stakeholders should remain committed to the principle of mutual
cooperation, which has been the core of sound development of the LNG industry,albeit in different shapes reflecting evolutional changes in it, bearing in mind LNG
projects are expected to continue requiring heavy investment and hencelong-term commitments between stakeholders.

2IEEJ: November 2014, All Rights ReservedAnnex.
1. Current situation
1.1 In recent years, the global LNG market has undergone major changes, accompaniedwith a lot of uncertainty in both supply and demand sides while increasing concerns
are expressed with large regional price differences, notably “Asian Premium”.

1.2 LNG supply-demand
1.2.1.

LNG demand is increasing in Asia which continues to enjoy economicgrowth. On the other hand, LNG demand is decreasing in the United States where
the shale revolution is changing gas supply-demand picture, and in Europe where
the economy is stagnating while the use of coal and renewable energy is rising.
Future outlook of demand is surrounded by uncertainty over government policies on
nuclear power, renewable energy and environmental issues.
1.2.2.

On the demand side, across the world, the number of LNG consuming

countries is increasing. The new LNG consuming countries include countries inAsia and the Middle East where the supply-demand gap of natural gas is expected
to increase, as well as some European, Central and South American countries
which aim to expand the use of natural gas (not only for power generation and othertraditional usage but also notably for transportation) and diversify supply sources.
1.2.3.

On the supply side, new LNG supplier countries have emerged in themarket. In addition to the traditional LNG supplying countries in Asia, the Middle
East, and Russia, more LNG projects are being developed. As more LNG exporting
capacity is expected to be operational albeit uncertainty, there is hope among LNG
consumers that they may have greater liquidity in the market and subsequently
more choices of supply sources

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IEEJ: November 2014, All Rights Reserved

LNG demand of major importers
mil. Ton

1009080Japan

706050Europe

4030

Korea

20USA

Other Americas

10China2013

2012

2011

2010

20092008

2007

2006

2005

2004

2002

2001

20002003

Chinese Taipei

0Source: Trade statistics in each country, IEA, EIA

LNG export / import by country in 2013

Others
19%
Qatar
33%
Russia4%
Algeria5%
Trinidad
6%
Nigeria
Malaysia
7%
10%
IndonesiaAustralia
7%9%

Exportin 2014

Others21%
United Kingdom
3%
Spain
5%
Chinese Taipei
5%
India
5%
China
7%

Japan37%

Importin 2013
Korea
17%

Source: BP, Statistical Review of World Energy 2014

Uncertainties in the future LNG market
Demand side
Supply side
・ Chinese economy
・ Impact of cost rises in new projects
・ Japan’s energy policy, restarting of nuclear ・ Hydraulic fracturing technology regulations
power stationsin North America
・ Competition with other fuels in power ・ Domestic natural gas demand in the US
generation
・ LNG export plan in the US
・ Domestic gas pricing system reforms in ・ Possibility to shape the market so that itsuch countries as India
guides investment decision-making(similar to oil market)・ Unconventional gas development in LNG
importing countries
・ Sharp increases in natural gas demand in
the Middle East
・ Steady increase in pipeline gas supply in
LNG importing countries
・ Possibe new development in Indonesia
Source: Multilateral Joint Study Group on LNG, 1st meeting

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IEEJ: November 2014, All Rights Reserved

LNG export potential from USA
FTA
non-FTA
Application filed (as of Jul 9, 2014) *413 Bcm
368 Bcm
Approved (as of Jul 9, 2014) *385 Bcm
95 BcmCompare with;World natural gas demand in 2013
3,348Bcm
World LNG trade in 2013
325BcmWorld top 3 gas exporter in 2013
Russia: 226 Bcm
Qatar: 126 Bcm
Norway: 106 Bcm* Sum of listed project capacities.
Source: Department of Energy, USA; BP, Statistical Review of World Energy 2014

Impact of restarting nuclear power plants in Japan
Power gen.
from nuclear
[TWh]
300

95

288

250
200
150

30
91

90
210
162

8985
80

80

002010 2014 2015

NoOperation
27.3
26.7
25.8
25.3
24.8

Low-level

24Mid-level

22High-level

77

75
42

28
26

124

100
50

Fossil fuelimport cost
[million ton]

LNG importamount[¥ trillion]

7071

70652010 2014 20152018.1182010 2014 2015

FullOperation

Source: IEEJ, Jul 2014

1.3 LNG price1.3.1.

Substantial gaps exist in gas prices between North America (USD

3-5/million Btu at Henry Hub), Europe (USD 9-15 at regional hubs and borders),and Asia (USD 15-17 at LNG import terminals). The price variations result fromvarious factors including differences in pricing mechanisms; North American prices
reflect gas supply-demand balances, European prices are linked both to oil prices
and hub prices, and Asian prices are linked to crude oil prices. The easing of gassupply and demand due to the shale revolution is the main cause of the current low
gas prices in the United States, while increases in crude oil prices since mid-2000’s

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IEEJ: November 2014, All Rights Reserved

are the main causes of the ever increasing LNG price in Asia.
1.3.2.

New ways of LNG pricing for future supply have already been observed,including Henry-Hub based ones from the United States and hybrid ones combining
oil-linkage and hub-based elements. This reflects the increase in the number ofbuyers and sellers as the LNG market develops.
1.3.3.

The low liquidity of international LNG transactions is also influencing pricevariations, while greater liquidity does not always mean lower prices. Spot andshort-term transactions have increased significantly in recent years to cope withdemand fluctuations and to take advantage of arbitrage opportunities between
regions, driven by portfolio players and producers with flexible capacity. Although
LNG prices may be inherently expensive due to the additional costs of liquefaction
and shipping, a delinking from oil prices might bring LNG prices lower than thecurrent ones. While possible lower oil prices may bring down oil-linked LNG
contract prices, different pricing mechanisms are expected to bring benefits ofdiversification.

Natural gas import price in major countries$/MMBtu25

Japan
NE Asia spot
20
UK
USA
15

10

5

Jan-2014

Jan-2013

Jan-2012

Jan-2011

Jan-2010

Jan-2009

Jan-2008

Jan-2007

Jan-2006

Jan-2005

Jan-2004

Jan-2003

Jan-2002

Jan-2001

Jan-2000

0Source: Energy Intelligence, EIA, Ministry of Finance GOJ

2. Challenges
2.1 A number of challenges exist to realize the development of sound LNG market.

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IEEJ: November 2014, All Rights Reserved

2.2 Regional differences of LNG prices
2.2.1.

In Asia, where energy consumption is on the rise, higher LNG prices may

become an important factor to hinder expansion of the LNG market. In particular, inthe power generation sector where the demand for natural gas is expected toincrease, the potential of natural gas use is not being fully realized orcommercialized due to the relative disadvantage in LNG’s price competitiveness.
Governments need to have clear and stable energy policies so that commercialplayers can make long term decisions within this framework.
2.2.2.

Higher LNG prices can consequently be a macroeconomic burden forimporters. Increasing demand for relatively cheap coal can reduce LNG exporters’
opportunities to develop their gas resources for new export projects. Higher pricesof LNG could prevent the fuel from fully performing its relative environmental
friendliness among fossil fuels.

2.3 Competitive situation of the LNG market
2.3.1.

Going forward, LNG will need to have more competitive pricing against

other energy sources, for the sound development of the LNG market. This requiresthat the market be sufficiently flexible and transparent.
2.3.2.

In the current LNG market, there already exists competition between

sellers and buyers, between sellers, and between buyers. On the supply side, many
new LNG projects are under way to come on stream. On the demand side, there
are multiple plans for new LNG import. Accordingly, competition in LNG
transactions could increase further. The advancement of electricity and gas market
reform in many consumer countries in Asia will also be a contributing factor, adding
more pressure to the competition.

Governments should continue to pursue suchreforms.
2.3.3.

However, it is important that initiatives need to be taken to further increase

market flexibility and transparency.
2.3.4.

The LNG market transparency has witnessed ongoing changes, including

the implementation of LNG spot price assessments in Asia in recent years. Furtherefforts are needed to disseminate highly transparent price information.
2.3.5.

The establishment of hub in Asia is one option which can contribute toenhance flexibility and transparency of the LNG market. At the same time, it isimportant to recognize that gas hub price is subject to substantial fluctuation orvolatility, and does not necessarily mean lower price.

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IEEJ: November 2014, All Rights Reserved

Oil / gas demand and share of internationally traded amount
4000

Mtoe

100%
90%

3500
Crude oildemand

3000
2500
2000

80%
70%
60%

share of crude
oil(rhs)

50%
40%

1500

30%

share ofgas(rhs)1000

Nat. gasdemand

500

20%
10%0%

01950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: United Nations

2.4 Soundness of transactions
2.4.1.

Many of the current LNG transaction practices continue reflect the issue

and concern of the past.
Long-term contracts and the introduction of take-or-pay clauses wereconsidered to assure investment recoveries for sellers (in particular in a lowprice environment) and were a means of ensuring stable supplies for buyers.
They had advantages for both.

Destination restrictions were initially introduced with an aim to ensure stable
export for sellers and stable import for buyers.

2.4.2.

However, some of the transaction practices, notably, the destination

restrictions, may have become obstacles to increasing flexibility and liquidity of theLNG market. Thus, the relaxation or elimination of destination restrictions are on
the agenda for a sound and transparent LNG market.
2.4.3.

Destination restrictions have lead to inefficiencies in the market. In

practice there have been a lot of reloadings of LNG cargoes in order to bringvolumes to final destinations - partly because of destination restrictions of theoriginal transactions. Without such restrictions savings could be expected bydirectly diverting volumes. Third party access to import terminals and pipelines aswell as reduced unnecessary regulation and restrictions on imports, such as inshipping, by buying countries would also reduce costs.

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IEEJ: November 2014, All Rights Reserved

2.4.4.

This is in line with the agreement reached at the G7 Summit (June 2014),

which set out that the G7 members would promote “flexible gas markets, including
relaxation of destination clauses.” Similar message which encourages “relaxingdestination clause” was delivered at the APEC Energy Ministerial Meeting(September 2014).
2.4.5.

However,

thefollowingissues

needtobekeptinmindinnegotiating/discussing transaction practices.
The current transaction practices are an outcome of negotiations andagreements between sellers and buyers in the market. As a general rule,changes to these practices must also be made through negotiations andagreements between sellers and buyers.

Liberalization in destinations needs to take into consideration issues andchallenges related to third party access to LNG receiving terminals, funding forthe construction of LNG vessels, and the operation of LNG vessels.

Shortening the contract term has a benefit to increase flexibility in the market.
However, it is necessary for LNG market stakeholders to take into account thecharacteristics of investments in natural gas supply chain including production
and liquefaction facilities when they attempting to shorten the contract term.
This also depends on the needs of the buyers, with many still preferring longterm stable supply for some portions of their procurement portfolios.

Cost of LNG chain

to ship/store same calorific value,
times higher than crude oil;cost is×7×4-9

Source: Wood Mackenzie, Deutsche BankEnd9IEEJ: November 2014, All Rights ReservedSupplement.

List of the Discussion Members
Philip Andrews-Speed

National University of Singapore, Singapore

Wayne CalderBureau of Resources and Energy Economics, Australia

Guy F.Caruso

Center for Strategic and International Studies, USA

Siri Jirapongphan

Petroleum Institute of Thailand, Thailand

Madhura Joshi

The Energy and Resource Institute, India

Ki Joong Kim

Korea Energy Economics Institute, Korea

Ying Chieh Lai

Taiwan Institute of Economic Research, Chinese Taipei

Chia-Jung Lu

Taiwan Institute of Economic Research, Chinese Taipei

Jane Nakano

Center for Strategic and International Studies, USAJin Ho ParkKorea Energy Economics Institute, Korea

Howard Rogers

The Oxford Institute for Energy Studies, United Kingdom

Abhishek Rohatgi

National University of Singapore, Singapore (at the time)

Anmol Soni

The Energy and Resource Institute, India (at the time)Laszlo Varro

International Energy Agency

Tsou Yi-Cheng

Taiwan Institute of Economic Research, Chinese Taipei

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Contact: report@tky.ieej.or.jp